Retirement & Financial Planning Report

A report from the Center for Retirement Research cautions against overlooking the tax impact of retirement income, saying that “As households approaching retirement examine the resources they will have available, they may forget that not all these resources belong to them.”

“Understanding the size of this liability can help individuals assess their own retirement security and also inform research on trends in wealth and on how wealth affects retirement decisions,” it says.

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The report broke households in a retiree database into five equal segments, or quintiles. It said that for households in the first four—with annual income from Social Security and defined benefits averaging just under $50,000—taxes take away only several percent of income, on average.

It found that the pattern held true regardless across three different ways of handling retirement savings, which for the first four segments was below about $160,000 in defined contribution savings plans (such as the TSP) and below about $195,000 in other assets. Those ways were: taking only required minimum distributions from their defined contribution plans and living off the interest and earnings of the other assets; taking only required distributions from the defined contribution plans, using half of the other assets to buy an annuity and taking only interest and earnings from the other half; and annuitizing all defined contribution savings and half of the other assets.

“In terms of financial security in retirement, this finding is good news – most households are not dramatically underestimating their retirement resources by not considering taxes,” it said.

“Taxes, however, are meaningful for the top quintile, so it is important to consider the economic circumstances of these households,” it said. That segment had Social Security and annuity income averaging about $77,000 and other wealth averaging above $763,000. For them, the tax bite on retirement income was 12-13 percent across the three methods of using savings.

Among the top 5 percent—averaging about $89,000 in guaranteed income and with just under $1 million in savings, on average—the tax bite was 16 percent. It added that although the database used in the study does not account for the “extremely wealthy,” for the top 1 percent in the database—with guaranteed income of about $93,000 and savings of $2.5 million on average—the bite is 23 percent.

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